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Friday, September 19, 2014

Small Countries’ Big Successes

by Michael O’Sullivan, Stefano Natella

ZURICH – Scotland’s vote on independence from the United Kingdom has spurred widespread debate about the secession of small states, such as Slovenia and Croatia in 1991, or the independence drive today in Spain’s autonomous region of Catalonia. But neither a narrow focus on the political and economic implications for Scotland and the UK – nor, for that matter, the referendum’s decisive pro-union outcome – should overshadow the broader lessons of one of the more overlooked geopolitical trends of our time: the rise of small countries.

Roughly 75% of today’s small countries were formed in the last 70 years, mostly as a result of broader democratic transitions and in tandem with trade growth and globalization. Their successes and failures are more germane to current discussions than, say, the fiscal implications of Scottish independence.

The lessons to be learned from these cases are useful not only to new and potentially new small countries. Relatively young small countries in Africa, the Caribbean, and the Middle East can also benefit by examining the secrets of Singapore’s success, the causes and effects of Ireland’s property bubble, and Denmark’s decision to build strong counter-terrorism capabilities, despite its relative safety. Indeed, such considerations can help them to chart a path to economic prosperity and social cohesion.

Of course, in learning from one another, countries must always be careful to avoid the “folly of imitation.” The Nordic countries, for example, have benefited significantly from deeply entrenched social, legal, and political characteristics that are not easy to transfer to their developing-country counterparts.

Moreover, young small countries must recognize that building the institutions and economies to which they aspire will take time. In fact, age may well be the most important factor in small-country performance, with per capita GDP in small countries that were established before 1945 some four times larger than in their newer counterparts.

In general, older small countries outstrip medium-size and large countries in terms of economic and social performance, openness to international trade, and enthusiasm for globalization – features that younger countries should work to promote. But small countries’ economic growth is often more volatile – a tendency that younger states must learn to contain if they are to prosper in the long term.

The question of “large” or “small” government is less relevant, despite the impression given by heated debates in large countries like the United States. Overall government expenditure is only weakly correlated with the size of the government. A better proxy would be public-sector salaries – the only area where large countries appear to benefit from economies of scale. Smaller countries spend more, as a percentage of GDP, on education and health care – another habit that new small countries would do well to uphold.

Indeed, there is a strong positive correlation between the pace of economic growth and “intangible infrastructure” – the combination of education, health care, technology, and the rule of law that promotes the development of human capital and enables businesses to grow efficiently. Small countries account for seven of the top ten countries for intangible infrastructure.

Add to that measures like the quality of institutions, suitability to thrive in a globalized world, stability of economic output, and level of human development, and one can generate a country strength index, in which 13 of the top 20 performers are small, with the most successful being Switzerland, Singapore, Denmark, Ireland, and Norway. A cluster of larger countries is led by Australia, the Netherlands, and the UK. Other “resilient” small countries include Finland, Austria, Sweden, and New Zealand.

To be sure, there is a clear “old European” bias here. Developing small states like Croatia, Oman, Kuwait, and Uruguay may consider exhortations to emulate countries like Switzerland and Norway to be impractical.

But a useful set of priorities can be gleaned from their experiences. Specifically, small developing countries should focus on building institutions, such as central banks and finance ministries, that explicitly seek to minimize the macroeconomic volatility associated with globalization. They should also advance the rule of law, develop strong and efficient public education and health-care systems, and encourage domestic industry to emphasize return, rather than cost of capital, as their guiding metric.

Beyond emulation, small countries can help one another through direct alliances. Surprisingly, very few such alliances exist, with many small countries – especially developing ones – cultivating close ties with “big brother” countries or immersing themselves in regional federal structures. The risk, of course, is that their voices become drowned out by larger entities, impeding their ability to do what is best for their own citizens.

In a fast-changing geopolitical and economic environment – characterized by challenges like interest-rate rises spurred by high debt levels; competitive corporate-tax reductions; changing immigration patterns; and a possible slowdown in the pace of globalization – small countries must be able to identify and assess risks, and adjust their strategies accordingly. Indeed, even without full independence, this is precisely what Scotland, which has been promised even greater autonomy within the UK than it already has, will have to do if it is to succeed.